I’ve discussed before that I’m overweight on energy holdings right now, and really have been for some time now. And that has occurred because I tend to take what the market gives me. I go where the value is, assuming quality is there as well. And the quality and value have both been present in that sector for a number of years now, which is why I’ve been fairly aggressive there over the last three or four years.
Well, the market giveth, and I taketh once more.
I had no intentions at all of averaging down again on the stock I’m going to discuss below. But I continue to believe the value is too compelling to pass up. I last purchased this stock in February at a price a bit more than 15% higher, and I thought that higher price was already very attractive. So you can imagine my surprise and excitement when I see a deal upon a deal. If the best time to be greedy is when others are fearful, then I feel good about my greed here.
With corporate history dating back to 1862, National-Oilwell Varco, Inc. (NYSE:NOV) is a leading worldwide provider of equipment and components used in oil and gas drilling and production, as well as oilfield services.
The company conducts operations in over 1,200 locations across six continents.
They operate in four segments: Rig Systems (42% of fiscal year 2014 revenue), Wellbore Technologies (24%), Completion & Production Solutions (20%), and Rig Aftermarket (14%).
NOV provides all the heavy equipment necessary for oil and gas drilling, including rigs, derricks, rotarys, blowout preventers, mud pumps, wireline winches, cranes, drill pipes, drilling motors, drill bits, and transfer pumps, among many other products. They are essentially a one-stop shop for their clients. Anecdotally, they are nicknamed “No Other Vendor” as a play on their stock ticker, referring to their dominance in their product lines.
Averaging Down Hard
I started purchasing this stock late last year near $70 per share. I then averaged down near $60 per share at the start of 2015 before my last purchase noted above. I planned on that being it, but NOV continues to drop and I continue to remain interested.
Averaging down really requires conviction and confidence. And that’s because if you’re wrong, you’re simply throwing good money after bad. If you buy a stock that’s worth $20 for, say, $50 and something happens to make the stock only worth $10, then averaging down over and over again isn’t a very good idea.
But I continue to think NOV isn’t just a really high-quality company that’s worth much more than what it’s trading for, but I believe the company will continue to grow the dividend, buy back shares, and eventually see the stock price recover.
I’ve averaged down hard like this before, and it’s generally served me well. Stocks like Digital Realty Trust, Inc. (DLR) and Target Corporation (TGT) fell significantly after initial purchases, only to later see both the respective dividends and stock prices rise.
As I’ve stated many times before, I quite look forward to the opportunity to average down on a stock I’ve already bought, assuming the long-term picture hasn’t drastically changed. I can’t predict what’s going to happen tomorrow. But I can predict with some reasonable accuracy that high-quality companies will be worth more with greater profits and bigger dividend payouts over the long term. As such, the less I pay to buy into something like that the better.
Solid Numbers During A Difficult Period
That’s in general terms. Specific to NOV, they continue to be plagued by low oil prices and reduced demand for their systems and products, which have weighed heavily on the firm. Although Q1 2015 results were actually incredibly solid considering the circumstances – Rig Systems (their largest segment) reported a revenue increase of 12% YOY – much of their business was a result of the backlog, which continues to dwindle. That means the book-to-bill is low, indicating that new orders have basically dried up. At $11.9 billion, the backlog is down significantly from the $14 billion it stood at at the end of fiscal year 2014.
Earnings per share is down considerably due to the headwinds they’re facing, but there is a silver lining here. The low price of the stock isn’t being noticed by just yours truly:
During the first quarter of 2015, the Company repurchased and retired 24.5 million shares of its common stock at an average price of $54.35 per share for a total purchase price of $1.3 billion. Since initiating a share buyback program in September 2014, the Company has repurchased 43.3 million shares or 10 percent of its shares outstanding, at an average price of $57.38 per share.
– Per the company’s Q1 report.
Buybacks can be criticized (management can’t time the stock market any better than anyone else), but I’m excited by the prospect of NOV retiring 10% of its shares outstanding at a price of $57.38 per share. The stock is obviously priced lower than that right now, but I personally would be very happy with 10% of the company at under $60 per share.
Moreover, the company remains fundamentally sound. They have an excellent balance sheet that allows them to remain flexible and a still-sizable backlog that should help buoy results for the rest of the year; and many of the products they provide eventually wear out, which should lead to improved orders down the line.
I always say that short-term volatility is a long-term opportunity. NOV has “been there, done that” in regards to volatility in oil pricing and business over the last 100+ years and they remain, thankfully, focused on the long term:
We have the financial resources to invest in acquisitions, as well as the transformative new technologies we have a long history of pioneering. Cyclical downturns provide extraordinary opportunities to deploy capital to better position our enterprise for a recovery. While we don’t know the duration of this downturn, we know that we will be better when the recovery comes.
– CEO, Clay C. Williams, in the Q1 report
I couldn’t agree more, Clay. That’s why I used this extraordinary opportunity to deploy capital and acquire shares in NOV. I had the financial resources to fund that acquisition, and that’s exactly what I did.
NOV’s major risk is the potential for a protracted drop in oil prices. If this situation remains as such for a long period of time, it very well could impact NOV’s ability to grow operations and its dividend. NOV is diversified across products and geographies, but they still rely on producers’ capital expenditures budgets.
In addition, they’re an aggressive acquirer, which could result in overpaying or integration issues.
Lastly, failure of a major component could tarnish NOV’s brand name.
The stock’s P/E ratio is just 8.83 right now, which includes depressed Q1 EPS. I find that extremely compelling. The five-year average P/E ratio for this stock stands at 14.1. Now, it’s very likely that EPS will remain weak throughout at least the next couple quarters, which will further depress TTM EPS and increase the P/E ratio (assuming the price stays at this level). But I happen to think NOV will be just fine for the long term. Results held up very well during the last significant drop in oil prices (2009), and they’re actually a larger company this time around.
I valued shares using a dividend discount model analysis with a 10% discount rate and a 7% long-term dividend growth rate. I lowered that growth rate slightly compared to my previous analysis to factor in the possibility of protracted weakness in their industry. But this growth rate is about 1/3 that of the firm’s EPS growth over the last decade. I think that’s a fair or even conservative long-term assumption. The DDM analysis gives me a fair value of $65.63.
Like I’ve mentioned many times now, NOV has been through the boom-and-bust cycles of the oil industry for about as long as the oil industry has been around. If any company is equipped to take advantage of the current market, it’s this company. The company’s financials remain incredibly strong, which puts them about as in control as they can possibly be, all considered.
My only issue with this stock is really the fact that the position is now a bit larger than I planned on it being. Not only am I overexposed to energy holdings in general, but certainly NOV specifically. I may use a tax-loss strategy to unload some more expensive shares to offset some capital gains I have and reduce this position somewhat. I’m 50/50 on that right now. But it’s not out of a lack of confidence in the stock. It’s rather about managing risk and exposure.
This stock is now down 30% YTD and approximately 45% over the last year. I suppose you have to ask yourself if NOV is permanently impaired that much. Is the business really worth about half of what it was last summer? I happen to believe not. The stock appears to offer a considerable margin of safety here, outside of oil staying at current levels indefinitely.
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